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**UNITED STATES SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

**FORM 10-Q**

 

**x****     ****QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period ended July 31, 2010**

 

**or**

 

**o****        ****TRANSITION REPORT PURSUANT TO SECTION 13 OR15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the transition period from [    ] to[    ]**

 

**Commission File No. 1-8125**

 

**TOROTEL, INC.**

(Exactname of registrant as specified in its charter)

 

| **MISSOURI**                                                      | ** ** | **44-0610086**                        |
|-------------------------------------------------------------------|------------|---------------------------------------|
| (State  or other jurisdiction of incorporation or   organization) |       | (I.R.S.  Employer Identification No.) |

 

| **620 NORTH LINDENWOOD DRIVE, OLATHE,   KANSAS** | ** ** | **66062**   |
|--------------------------------------------------|------------|-------------|
| (Address  of principal executive offices)        |       | (Zip  Code) |

 

**(913) 747-6111**

(Registrant’stelephone number, including area code)

 

Indicate bycheck mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.   Yes x No o

 

Indicate bycheck mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 ofthis chapter) during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files).   Yes o Noo

 

Indicate bycheck mark whether the registrant is a large accelerated filer, an acceleratedfiler, a non-accelerated filer or a smaller reporting company.  See thedefinitions of “large accelerated filer,” “accelerated filer” and “smallerreporting company” in Rule 12b-2 of the Exchange Act.

 

| Large  accelerated filer o                                              |   | Accelerated  filer o         |
|-------------------------------------------------------------------------|--------|------------------------------|
|                                                                    |   |                         |
| Non-accelerated  filer o  (Do not check if a smaller reporting company) |   | Smaller  reporting company x |

 

Indicate bycheck mark whether the registrant is a shell company (as defined inRule 12b-2 of the Securities Exchange Act of 1934).   Yes o Nox

 

As of September 10,2010, there were 5,873,100 shares of Common Stock, $.01 par value, outstanding.

 

 

 

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TOROTEL, INC.AND SUBSIDIARIES

 

INDEX

 
| PART I.  | FINANCIAL INFORMATION                                                                          |   |   |
|---------------|------------------------------------------------------------------------------------------------|--------|--------|
|          |                                                                                           |   |   |
| Item 1.       | Financial Statements                                                                           |   |   |
|          |                                                                                           |   |   |
|          | Consolidated  Condensed Balance Sheets as of July 31, 2010 and April 30, 2010        |   | 3      |
|          |                                                                                           |   |   |
|          | Consolidated  Statements of Operations for the three months ended July 31, 2010 and  2009 |   | 4      |
|          |                                                                                           |   |   |
|          | Consolidated  Statements of Cash Flows for the three months ended July 31, 2010 and  2009 |   | 5      |
|          |                                                                                           |   |   |
|          | Notes to Consolidated Condensed Financial Statements                                           |   | 6      |
|          |                                                                                           |   |   |
| Item 2.       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations    |   | 12     |
|          |                                                                                           |   |   |
| Item 3.       | Quantitative  and Qualitative Disclosures About Market Risk                                    |   | 18     |
|          |                                                                                           |   |   |
| Item 4T.      | Controls and  Procedures                                                                       |   | 18     |
|          |                                                                                           |   |   |
| PART II. | OTHER INFORMATION                                                                              |   |   |
|          |                                                                                           |   |   |
| Item  6.      | Exhibits                                                                                       |   | 19     |
|          |                                                                                           |   |   |
| SIGNATURES    |                                                                                           | 20     |
|               |                                                                                                |        |        |  |

 

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** **

**PART I.     FINANCIAL INFORMATION**

 

**Item 1.       FinancialStatements**

 

**CONSOLIDATED CONDENSED BALANCE SHEETS**

 
| ** **                                | ** ** | **(Unaudited)**   | ** ** | ** **         | ** ** |
|-------------------------------------------|------------|-------------------|------------|--------------------|------------|
| ** **                                | ** ** | **As of**    | ** ** | **As of**     | ** ** |
| ** **                                | ** ** | **July 31,** | ** ** | **April 30,** | ** ** |
| ** **                                | ** ** | **2010**          | ** ** | **2010**           | ** ** |
| ASSETS                                    |       |              |       |               |       |
|                                      |       |              |       |               |       |
| Current assets:                           |       |              |       |               |       |
| Cash                                      |       | $                 | 704,000    |               | $          | 1,030,000 |   |
| Trade receivables, net                    |       | 1,246,000         |       | 920,000            |       |
| Inventories, net                          |       | 1,276,000         |       | 1,220,000          |       |
| Prepaid expenses and other current assets |       | 74,000            |       | 27,000             |       |
|                                      |       | 3,300,000         |       | 3,197,000          |       |
|                                      |       |              |       |               |       |
| Property, plant and equipment, net        |       | 992,000           |       | 963,000            |       |
|                                      |       |              |       |               |       |
| Other assets                              |       | 19,000            |       | —             |       |
|                                      |       |              |       |               |       |
|                                      |       | $                 | 4,311,000  |               | $          | 4,160,000 |   |
|                                      |       |              |       |               |       |
| LIABILITIES AND STOCKHOLDERS’ EQUITY |       |              |       |               |       |
|                                      |       |              |       |               |       |
| Current liabilities:                      |       |              |       |               |       |
| Current maturities of long-term debt      |       | $                 | 106,000    |               | $          | 101,000 |   |
| Trade accounts payable                    |       | 605,000           |       | 311,000            |       |
| Accrued liabilities                       |       | 141,000           |       | 244,000            |       |
| Customer deposits                         |       | 723,000           |       | 978,000            |       |
|                                      |       | 1,575,000         |       | 1,634,000          |       |
|                                      |       |              |       |               |       |
| Long-term debt, less current maturities   |       | 497,000           |       | 514,000            |       |
|                                      |       |              |       |               |       |
| Stockholders’ equity                 |       | 2,239,000         |       | 2,012,000          |       |
|                                      |       |              |       |               |       |
|                                      |       | $                 | 4,311,000  |               | $          | 4,160,000 |   |

 

Theaccompanying notes are an integral part of these statements.

 

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** **

**CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)**

 
| ** **                                        | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------|------------|----------------------------------|------------|
| ** **                                        | ** ** | **July 31,**                | ** ** | **July 31,** | ** ** |
| ** **                                        | ** ** | **2010**                         | ** ** | **2009** | ** ** |
| Net sales                                         |       | $                                | 2,494,000  |   | $ | 1,537,000 |   |
| Cost of goods sold                                |       | 1,597,000                        |       | 984,000 |   |
|                                              |       |                             |       |   |   |
| Gross profit                                      |       | 897,000                          |       | 553,000 |   |
|                                              |       |                             |       |   |   |
| Operating expenses:                               |       |                             |       |   |   |
| Engineering                                       |       | 69,000                           |       | 92,000 |   |
| Selling, general and administrative               |       | 606,000                          |       | 558,000 |   |
|                                              |       | 675,000                          |       | 650,000 |   |
| Earnings (loss) from operations                   |       | 222,000                          |       | (97,000 | ) |
|                                              |       |                             |       |   |   |
| Other expense (income):                           |       |                             |       |   |   |
| Interest expense                                  |       | 10,000                           |       | 12,000 |   |
| Interest income                                   |       | (3,000                           | )          | — |   |
|                                              |       | 7,000                            |       | 12,000 |   |
|                                              |       |                             |       |   |   |
| Earnings (loss) before provision for income taxes |       | 215,000                          |       | (109,000 | ) |
|                                              |       |                             |       |   |   |
| Provision for income taxes                        |       | —                           |       | — |   |
|                                              |       |                             |       |   |   |
| Net earnings (loss)                               |       | $                                | 215,000    |   | $ | (109,000 | ) |
|                                              |       |                             |       |   |   |
| Basic earnings (loss) per share                   |       | $                                | .04        |   | $ | (.02 | ) |

 

Theaccompanying notes are an integral part of these statements.

 

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**CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)**

 
| ** **                                                                              | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                              | ** ** | **July 31,**                | ** ** | **July 31,** | ** ** |
| ** **                                                                              | ** ** | **2010**                         | ** ** | **2009** | ** ** |
| Cash flows from operating activities:                                                   |       |                             |       |   |   |
| Net earnings (loss)                                                                     |       | $                                | 215,000    |   | $ | (109,000 | ) |
| Adjustments to reconcile net earnings (loss) to net  cashused  in operating activities: |       |                             |       |   |   |
| Stock compensation earned                                                               |       | 12,000                           |       | 11,000 |   |
| Depreciation                                                                            |       | 31,000                           |       | 25,000 |   |
| Change in value of stock appreciation rights                                            |       | 7,000                            |       | 9,000 |   |
| Increase (decrease) in cash flows from operations  resulting from changes in:           |       |                             |       |   |   |
| Trade receivables                                                                       |       | (326,000                         | )          | (29,000 | ) |
| Inventories                                                                             |       | (56,000                          | )          | 23,000 |   |
| Prepaid expenses and other assets                                                       |       | (66,000                          | )          | (53,000 | ) |
| Trade accounts payable                                                                  |       | 294,000                          |       | 115,000 |   |
| Accrued liabilities                                                                     |       | (110,000                         | )          | (99,000 | ) |
| Customer deposits                                                                       |       | (255,000                         | )          | — |   |
|                                                                                    |       |                             |       |   |   |
| Net cash used in operating activities                                                   |       | (254,000                         | )          | (107,000 | ) |
|                                                                                    |       |                             |       |   |   |
| Cash flows from investing activities:                                                   |       |                             |       |   |   |
| Capital expenditures                                                                    |       | (47,000                          | )          | (30,000 | ) |
|                                                                                    |       |                             |       |   |   |
| Net cash used in investing activities                                                   |       | (47,000                          | )          | (30,000 | ) |
|                                                                                    |       |                             |       |   |   |
| Cash flows from financing activities:                                                   |       |                             |       |   |   |
| Proceeds from long-term debt                                                            |       | —                           |       | 21,000 |   |
| Principal payments on long-term debt                                                    |       | (19,000                          | )          | (18,000 | ) |
| Payments on capital lease obligations                                                   |       | (6,000                           | )          | (2,000 | ) |
|                                                                                    |       |                             |       |   |   |
| Net cash provided by (used in) financing activities                                     |       | (25,000                          | )          | 1,000 |   |
|                                                                                    |       |                             |       |   |   |
| Net decrease in cash                                                                    |       | (326,000                         | )          | (136,000 | ) |
| Cash, beginning of period                                                               |       | 1,030,000                        |       | 656,000 |   |
|                                                                                    |       |                             |       |   |   |
| Cash, end of period                                                                     |       | $                                | 704,000    |   | $ | 520,000 |   |
|                                                                                    |       |                             |       |   |   |
| Supplemental Disclosures of Cash Flow Information                                       |       |                             |       |   |   |
| Cash paid during the period for:                                                        |       |                             |       |   |   |
| Interest                                                                                |       | $                                | 10,000     |   | $ | 12,000 |   |
| Income taxes                                                                            |       | $                                | —     |   | $ | — |   |
|                                                                                    |       |                             |       |   |   |
| Non-cash investing and financing activities:                                            |       |                             |       |   |   |
| Capital expenditure                                                                     |       | $                                | (13,000    | ) | $ | — |   |
| Proceeds from capital lease                                                             |       | $                                | 13,000     |   | $ | — |   |

 

Theaccompanying notes are an integral part of these statements.

 

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**NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS(Unaudited)**

 

**Note 1 — Basis of Presentation**

 

Theconsolidated condensed balance sheet as of April 30, 2010, which has beenderived from audited financial statements, is accompanied by the unauditedinterim consolidated condensed financial statements, which reflect the normalrecurring adjustments that in the opinion of management are necessary topresent fairly Torotel’s consolidated financial position at July 31, 2010,and the consolidated results of operations for the three months endedJuly 31, 2010.

 

Theunaudited interim consolidated condensed financial statements have beenprepared pursuant to the rules and regulations of the Securities andExchange Commission.  Certain information and note disclosures normallyincluded in the annual financial statements prepared in accordance withgenerally accepted accounting principles have been condensed or omitted pursuantto those rules and regulations, although management believes thedisclosures made are adequate to make the information not misleading.

 

Thefinancial statements contained herein should be read in conjunction withTorotel’s consolidated financial statements and related notes filed onForm 10-K for the year ended April 30, 2010.

 

**Note 2 — Nature of Operations**

 

Torotel, Inc.(“Torotel”) conducts business primarily through three wholly ownedsubsidiaries, Torotel Products, Inc. (“Torotel Products”), Torotel ManufacturingCorp. (“TMC”), and Electronika, Inc. (“Electronika”).  TMC providesmanufacturing services to Torotel Products. Torotel specializes in the custom design and manufacture of a widevariety of precision magnetic components, consisting of transformers,inductors, reactors, chokes and toroidal coils, for use in commercial,industrial and military electronics.  Torotel also designs and distributesballast transformers for the airline industry.  Approximately 96% ofTorotel’s sales during the first three months of fiscal 2011 have been derivedfrom domestic customers.

 

**Note 3 — Inventories**

 

Thecomponents of inventories are summarized as follows:

 
| ** **      | ** ** | **July 31,** | ** ** | **April 30,** | ** ** |
|-----------------|------------|-------------------|------------|--------------------|------------|
| ** **      | ** ** | **2010**          | ** ** | **2010**           | ** ** |
| Raw materials   |       | $                 | 720,000    |               | $          | 761,000 |   |
| Work in process |       | 347,000           |       | 256,000            |       |
| Finished goods  |       | 209,000           |       | 203,000            |       |
|            |       | $                 | 1,276,000  |               | $          | 1,220,000 |   |

 

**Note 4 — Income Taxes**

 

As ofJuly 31, 2010, the federal tax returns for the fiscal years ended 2006through 2010 will remain open to audit until the statute of limitations closesfor the years in which the net operating losses are utilized.  Torotelwould recognize interest and penalties accrued on unrecognized tax benefits aswell as interest received from favorable tax settlements within income taxexpense.  As of July 31, 2010, Torotel recorded no accrued interestor penalties related to uncertain tax positions.  Management expects nosignificant change in the amount of unrecognized tax benefit, accrued interestor penalties within the next twelve months.

 

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** **

**Note 5 — Financing Agreements**

 

Torotel Products maintains a $500,000 revolving creditagreement with Bank of Blue Valley.  Advances under the credit line arelimited to 75% of eligible billed receivables.  The revolving line iscollateralized by the land and buildings in Olathe, Kansas.  Under theterms of the agreement, the outstanding balance of the revolving line bearsinterest at 1.00% over the bank’s corporate base rate with an interest ratefloor of 6.00% and has a maturity date of September 30, 2010.  As ofJuly 31, 2010, the effective borrowing rate was 6.00% and the entirecredit line was available.  We anticipaterenewal of the credit line on similar terms.

 

**Note 6 — Restricted Stock Agreements**

 

Restricted Stock Agreements are authorized by theCompensation and Nominating Committee (“Committee”) and the Board of Directorsof Torotel.  The Committee and the Board have determined that theinterests of Torotel and its stockholders will be promoted by hiring talentedindividuals and, to induce such individuals to accept employment with Torotel,the Committee and the Board believe a key component of such individuals’compensation should be granting equity ownership opportunities based upon theacceptance of employment and the continuing employment of such individuals,subject to certain conditions and restrictions.  The Restricted StockAgreements afford the grantees all of the rights of a stockholder with respectto the award shares, including the right to vote such shares and to receivedividends and other distributions payable with respect to such shares since theDate of Award.  Under the terms of each agreement, the non-vested sharesare restricted as to disposition and subject to forfeiture under certaincircumstances.  The agreements further provide, subject to certainconditions, that if prior to all of the restricted shares having been released,Torotel undergoes a change in control, then all of the restricted shares shallbe released from all restrictions under the agreements.  Upon issuance ofthe restricted stock, the aggregate number of shares issued is credited tocommon stock at $.01 par value per share and the excess of the market price ofthe common stock on the date of issuance over the par value is credited tocapital in excess of par value.  The restricted shares are treated asnon-vested stock; accordingly, the fair value of the restricted stock at thedate of award is offset against capital in excess of par value in theaccompanying consolidated balance sheets under stockholders’ equity.

 

Torotel has Restricted Stock Agreements datedAugust 7, 2007, with eight key employees pursuant to the Stock Award Plan(“SAP”).  The SAP provides key employees the opportunity to acquire commonstock of Torotel pursuant to awards earned for accomplishing goals that promotethe long-term financial performance of Torotel.  Under the terms of theSAP, which was filed as Exhibit 10.9 of Form 10-KSB for the fiscalyear ended April 30, 2007, the restricted stock awards have a five yearrestriction period, which shall lapse based on certain conditions as outlinedin the SAP.  As of July 31, 2010, the aggregate amount of theexisting restricted stock awards was 357,350 shares.  Stock compensationcost of $9,000 for the existing restricted stock awards will be recorded perquarter during the remaining five-year vesting period provided the financialperformance metrics as outlined in the SAP are likely to be attained.

 

On September 2, 2009, Torotel entered intoRestricted Stock Agreements with two (2) key employees(Messrs. Sizemore and Serrone) pursuant to the SAP.  The aggregateamount of the restricted stock awards was 250,000 shares of common stock, $.01par value per share.  Based on the market price of $.27 for Torotel’scommon stock as of September 2, 2009, the fair value of the restrictedstock at the date of award was $67,500.  Stock compensation cost of $3,000will be recorded per quarter during the five-year vesting period provided thefinancial performance metrics as outlined in the SAP are likely to be attained.

 

Total stockcompensation cost for all Restricted Stock Agreements for the three monthsended July 31, 2010 and 2009 was $12,000 and $11,000, respectively.

 

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Restrictedstock activity for each three month period through July 31 is summarizedas follows:

 
| ** **                  | ** ** | **2010**       | ** ** | **2009**     | ** ** |
|-----------------------------|------------|----------------|------------|--------------|------------|
| ** **                  | ** ** | **Restricted** | ** ** | **Weighted** | ** ** | **Restricted** | ** ** | **Weighted** | ** ** |
| ** **                  | ** ** | **Shares**     | ** ** | **Average**  | ** ** | **Shares** | ** ** | **Average** | ** ** |
| ** **                  | ** ** | **Under**      | ** ** | **Grant**    | ** ** | **Under** | ** ** | **Grant** | ** ** |
| ** **                  | ** ** | **Option**     | ** ** | **Price**    | ** ** | **Option** | ** ** | **Price** | ** ** |
| Outstanding at May 1   |       | 607,350        |       | $            | .405       |   | 434,910 |   | $ | .500 |   |
| Granted                     |       | —         |       | —       |       | — |   | — |   |
| Vested                      |       | —         |       | —       |       | — |   | — |   |
| Forfeited                   |       | —         |       | —       |       | — |   | — |   |
| Outstanding at July 31 |       | 607,350        |       | $            | .405       |   | 434,910 |   | $ | .500 |   |

 

**Note 7 — Stockholders’ Equity**

 

Thecomponents of stockholders’ equity are summarized as follows:

 
| ** **                     | ** ** | **July 31,** | ** ** | **April 30,** | ** ** |
|--------------------------------|------------|-------------------|------------|--------------------|------------|
| ** **                     | ** ** | **2010**          | ** ** | **2010**           | ** ** |
| Common stock, at par value     |       | $                 | 60,000     |               | $          | 60,000 |   |
| Capital in excess of par value |       | 12,483,000        |       | 12,471,000         |       |
| Accumulated deficit            |       | (10,285,000       | )          | (10,500,000        | )          |
|                           |       | 2,258,000         |       | 2,031,000          |       |
| Less treasury stock, at cost   |       | 19,000            |       | 19,000             |       |
|                           |       | $                 | 2,239,000  |               | $          | 2,012,000 |   |

 

Torotel has 6,000,000shares of common stock, $.01 par value, authorized and 5,873,100 shares issuedand outstanding.  The changes in shares of common stock outstanding as ofJuly 31 of each period are summarized as follows:

 
| ** **                | ** ** | **2010**  | ** ** | **2009**  | ** ** |
|---------------------------|------------|-----------|------------|-----------|------------|
| Balance, May 1       |       | 5,873,100 |       | 5,666,500 |       |
| Restricted stock activity |       | —    |       | —    |       |
| Treasury stock activity   |       | —    |       | —    |       |
|                      |       |      |       |      |       |
| Balance, July 31     |       | 5,873,100 |       | 5,666,500 |       |

 

**Note 8 — Earnings Per Share**

 

Basic anddiluted earnings per share is computed using the two-class method. Thetwo-class method is an earnings allocation formula that determines net incomeper share for each class of common stock and participating security accordingto dividends declared and participation rights in undistributed earnings. Pershare amounts are computed by dividing net income attributable to commonshareholders by the weighted average shares outstanding during each period.

 

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The basicearnings per common share were computed as follows:

 

Year-to-Date EPS Calculations

 
| ** **                                                                   | ** ** | **2010**  | ** ** | **2009**  | ** ** |
|------------------------------------------------------------------------------|------------|-----------|------------|-----------|------------|
| Net earnings (loss)                                                          |       | $         | 215,000    |      | $          | (109,000 | ) |
| Amounts allocated to participating securities  (nonvested restricted shares) |       | (22,000   | )          | —    |       |
| Net income attributable to common shareholders                               |       | $         | 193,000    |      | $          | (109,000 | ) |
| Basic weighted average common shares                                         |       | 5,265,750 |       | 5,231,590 |       |
| Earnings per share attributable to common  shareholders:                     |       |      |       |      |       |
| Basic earnings (loss) per share                                              |       | $         | .04        |      | $          | (.02 | ) |

 

ASC 260, *Earnings per Share*, provides that unvested share-basedpayment awards that contain non-forfeitable rights to dividends are consideredto be participating securities and must be included in the computation ofearnings per share pursuant to the two-class method.  Diluted earnings per share is not presentedas Torotel does not have any shares considered incremental and dilutive. Forthe 2009 year to date earnings per share calculation, the participatingsecurities identified above do not contain contractual obligations to participatein the losses of Torotel and are not classified using the two-class method.

 

**Note 9 — Stock Appreciation Rights**

 

The board ofdirectors of Torotel approved the Directors Stock Appreciation Rights Plan (the“Plan”) for non-employee directors in September 2004.  Each stockappreciation right (“SAR”) is equal to one share of common stock of Torotel,and the aggregate number of SARs that may be granted under the Plan shall notexceed 500,000.  The effective date of the Plan is October 1, 2004,and the Plan has a term of ten (10) years.

 

Pursuant tothe Plan, 20,000 SARs were granted on the effective date to each of the threecurrent non-employee directors serving at that time.  The initial price atwhich each SAR was granted was $.35, which equaled the market price of Torotel’scommon stock on the date of grant.  Accordingly, no compensation cost wasrecognized at the time of grant.

 

SARs shallautomatically be granted in the future as follows: (1) each person who iselected as a director, who was not a director on the effective date of thePlan, shall be granted 10,000 SARs on the date such person is elected adirector; and (2) on each May 1 following the effective date duringthe term of the Plan, each person serving as a director on such date shall begranted 10,000 SARs.  After the initial grant the price at which each SARis granted shall be the average of the closing price of Torotel’s common stockfor the ten consecutive days immediately preceding the date of grant. Upon exercise of a SAR, Torotel will pay the grantee an amount (the “Spread”)equal to the excess of the Exercise Price over the SAR grant price multipliedby the number of shares being exercised.  The Exercise Price shall be theaverage of the closing price of Torotel’s common stock for the ten consecutivedays immediately preceding the notice of exercise.  For any payments thatexceed $10,000, Torotel has the option to make quarterly payments over threeyears with interest payable quarterly at the prime rate of Torotel’s primarybank.

 

Each SARgranted under the Plan may be exercised to the extent that the grantee isvested in such SAR.  The SARs will vest according to the followingschedule:

 
| **Number of Years the Grantee has remained** | ** ** | **Shares represented**               | ** ** |
|----------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| **a Torotel director following**                            | ** ** | **by a SAR in which** | ** ** |
| **the Date of Grant**                                       | ** ** | **a Grantee is Vested**    | ** ** |
| Under one                                                                  |       | 0                                         | %          |
| At least one but less than two                                             |       | 33                                        | %          |
| At least two but less than three                                           |       | 67                                        | %          |
| Three or more                                                              |       | 100                                       | %          |

 

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A granteeshall become fully vested in all of his or her SARs under the followingcircumstances: (i) upon termination of the grantee’s service as a directorof Torotel for reasons of death, disability or retirement; (ii) if theCompensation and Nominating Committee (the “Committee”), in its solediscretion, determines that acceleration of the SAR vesting schedule would bedesirable for Torotel; or (iii) if Torotel shall, pursuant to action byits Board of Directors, at any time propose to merge into, consolidate with, orsell or otherwise transfer all or substantially all of its assets to anothercorporation, and provision is not made pursuant to the terms of suchtransaction for the assumption by the surviving, resulting or acquiringcorporation of outstanding SARs or for substitution of new SARs therefor, theCommittee shall cause written notice of the proposed transaction to be given toeach grantee not less than twenty days prior to the anticipated effective dateof the proposed transaction, and his or her SARs shall become fully vested and,prior to a date specified in such notice, which shall be not more than ten daysprior to the anticipated effective date of the proposed transaction, eachgrantee shall have the right to exercise all of his or her SARs.

 

Compensationexpense is recognized over the vesting period based upon the estimated fairvalue of the SARs pursuant to the terms of the Plan using the Black-Scholesoptions-pricing model as of the end of each financial reporting period. As of July 31, 2010, the fair value of the SARs was determined using thefollowing assumptions: no dividend payments over the life of the SARs sinceTorotel has not issued any form of dividend since 1985; an expected volatilityof 103.11% based on Torotel’s historical volatility using the weekly closingprice over the past three years; a risk-free interest rate of 1.8%; and anexpected life of three years based on the length of service estimated to beserved.  As of July 31, 2009, the fair value of the SARs wasdetermined using the following assumptions: no dividend payments over the lifeof the SARs since Torotel has not issued any form of dividend since 1985; anexpected volatility of 114.9% based on Torotel’s historical volatility usingthe weekly closing price over the past three years; a risk-free interest rateof 2.50%; and an expected life of three years based on the length of serviceestimated to be served.   Based on these assumptions, the fair valueprices per share of the outstanding SARs as of July 31, 2010, aresummarized as follows:

 
| ** **           | ** ** | **SARs**   | ** ** | ** **   | ** ** | ** **          | ** ** | ** ** | ** ** | **Aggregate**       | ** ** | **Aggregate** | ** ** |
|----------------------|------------|------------|------------|--------------|------------|---------------------|------------|------------|------------|---------------------|------------|---------------|------------|
| ** **           | ** ** | **Under**  | ** ** | **Exercise** | ** ** | **Fair Value** | ** ** | **%**      | ** ** | **Vested**          | ** ** | **Intrinsic** | ** ** |
| **Grant Date**  | ** ** | **Option** | ** ** | **Price**    | ** ** | **Price**           | ** ** | **Vested** | ** ** | **Fair Value** | ** ** | **Value**     | ** ** |
| October 1, 2004 |       | 60,000     |       | $            | .350       |                | $          | .183       |       | 100                 | %          | $             | 11,000     |   | $ | — |   |
| May 1, 2005     |       | 30,000     |       | $            | .302       |                | $          | .191       |       | 100                 | %          | $             | 6,000      |   | $ | — |   |
| May 1, 2006     |       | 30,000     |       | $            | .695       |                | $          | .142       |       | 100                 | %          | $             | 4,000      |   | $ | — |   |
| May 1, 2007     |       | 30,000     |       | $            | .500       |                | $          | .162       |       | 100                 | %          | $             | 5,000      |   | $ | — |   |
| June 4, 2007    |       | 10,000     |       | $            | .412       |                | $          | .174       |       | 100                 | %          | $             | 2,000      |   | $ | — |   |
| May 1, 2008     |       | 40,000     |       | $            | .550       |                | $          | .156       |       | 67                  | %          | $             | 4,000      |   | $ | — |   |
| May 1, 2009     |       | 40,000     |       | $            | .208       |                | $          | .211       |       | 33                  | %          | $             | 3,000      |   | $ | 3,000 |   |
| May 1, 2010     |       | 40,000     |       | $            | .300       |                | $          | .191       |       | 0                   | %          | $             | —     |   | $ | — |   |

 

The vestedportion represents 200,000 SARs.  As of July 31, 2010, the totalaggregate intrinsic value of these exercisable SARs was $3,000.

 

SARstransactions for the three month periods ended July 31, 2010 and 2009 aresummarized as follows:

 
| ** **                                                     | ** ** | **2010**   | ** ** | **2009**     | ** ** |
|----------------------------------------------------------------|------------|------------|------------|--------------|------------|
| ** **                                                     | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                                                     | ** ** | **SARs**   | ** ** | **Average**  | ** ** | **SARs** | ** ** | **Average** | ** ** |
| ** **                                                     | ** ** | **Under**  | ** ** | **Grant**    | ** ** | **Under** | ** ** | **Grant** | ** ** |
| ** **                                                     | ** ** | **Option** | ** ** | **Price**    | ** ** | **Option** | ** ** | **Price** | ** ** |
| Outstanding at May 1                                      |       | 240,000    |       | $            | .418       |   | 200,000 |   | $ | .460 |   |
| Granted                                                        |       | 40,000     |       | $            | . 300      |   | 40,000 |   | $ | .208 |   |
| Exercised                                                      |       | —     |       | —       |       | — |   | — |   |
| Forfeited                                                      |       | —     |       | —       |       | — |   | — |   |
| Outstanding at July 31                                    |       | 280,000    |       | $            | .401       |   | 240,000 |   | $ | .418 |   |
|                                                           |       |       |       |         |       |   |   |   |   |
| SARs exercisable at end of period                              |       | 200,000    |       | $            | .438       |   | 160,000 |   | $ | .444 |   |
| Weighted average fair value of SARs granted during  the period |       |       |       | $            | .191       |   |   |   | $ | .192 |   |

 

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Thefollowing information applies to SARs outstanding for each for the three monthperiods ended July 31, 2010 and 2009:

 
| ** **                                  | ** ** | **2010**       | ** ** | **2009**       | ** ** |
|---------------------------------------------|------------|----------------|------------|----------------|------------|
| Number outstanding                          |       | 280,000        |       | 240,000        |       |
| Range of grant prices                       |       | $.208  - $.695 |       | $.208  - $.695 |       |
| Weighted average grant price                |       | $.401          |       | $.418          |       |
| Weighted average remaining contractual life |       | 6.74  yrs.     |       | 7.23  yrs.     |       |

 

Totalcompensation expense for the outstanding SARs for the three months endedJuly 31, 2010 and 2009 was an expense of $7,000 and $9,000,respectively.  As of July 31, 2010, there was $8,000 of totalunrecognized compensation expense related to non-vested SARs granted under thePlan.  That cost is expected to be recognized over a weighted averageperiod of .75 years.  The liability for SARs on the consolidated condensedbalance sheets as of July 31, 2010 and April 30, 2010, was $35,000and $28,000, respectively.

 

**Note 10 —****Customer Deposits**

 

The currentcontract for the potted coil assembly provides for milestone payments in theaggregate amount of $1,148,000 paid by the customer prior to the commencementof product deliveries in April 2010. This aggregate amount was used toprocure raw materials and to establish a 500-piece finished goods buffer asrequested by the customer. As of July 31, 2010, Torotel had receivedmilestone payments aggregating $1,148,000. These milestone payments are appliedto invoices ratably over the course of the contract as product is delivered. Inaccordance with our revenue recognition policy, Torotel recognizes revenue onthis contract upon monthly shipment of the product. As of July 31, 2010,the customer deposit liability was $723,000. This net amount is reflected as acustomer deposit under current liabilities in the accompanying consolidatedcondensed balance sheet.

 

**Note 11 —****Concentrations of Credit Risk**

 

Financialinstruments that potentially subject Torotel to concentrations of credit riskconsist principally of cash and accounts receivable.  Torotel grantsunsecured credit to most of its customers.  Management does not believethat it is exposed to any extraordinary credit risk as a result of thispolicy.  At various times, and at July 31, 2010, cash balancesexceeded federally insured limits.  Torotel has not experienced any lossesin the cash accounts and management does not believe Torotel is exposed to anysignificant credit risk with respect to its cash.

 

**Note 12 —****Real Estate Lease**

 

OnJuly 30, 2010, Torotel entered into a 42 month real estate lease agreementwith 96-OP Prop, LLC to lease approximately 18,000 square feet formanufacturing injection molded products, electromechanical assemblies, andlarger transformers.  This facility is located in close proximity to theprimary facility of Torotel in Olathe, KS. This agreement commences on September 1, 2010 and continues throughFebruary 28, 2014.  The monthly base rent will be $9,485.  Theaggregate base rent payments during the term of the lease will be approximately$398,000.  A copy of the agreement has been filed as an exhibit to theCurrent Report on Form 8-K filed on August 4, 2010.

 

**Note 13 —****New Accounting Pronouncement**

 

Torotel adopted ASU No. 2009-17 Consolidations(Topic 810), *Improvements to Financial Reporting byEnterprises Involved with Variable Interest Entities*.  This update requires a qualitative approachto identifying a controlling financial interest in a variable interest entity (“VIE”)and requires ongoing assessment of whether an entity is a VIE and whether aninterest in a VIE makes the holder the primary beneficiary of the VIE.  In addition, this new guidance requiresadditional disclosures about the involvement with a VIE and any significantchanges in risk exposure due to that involvement.  This new guidance is effective for fiscal yearsbeginning after November 15, 2009. At adoption and as of July 31, 2010, we were not involved in anyVIE and there was no impact from adoption.

 

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** **

**Forward-Looking Information**

 

*This report, as well as our otherreports filed with the Securities and Exchange Commission (“SEC”), and in pressreleases and other public communications throughout the year, contains forward-lookingstatements made pursuant to the safe harbor provisions of The PrivateSecurities Litigation Reform Act of 1995. The words “believe,” “estimate,” “anticipate,”“project,” “intend,” “expect,” “plan,” “outlook,” “forecast,” “may,” “will,” “should,”“continue,” “predict” and similar expressions are intended to identifyforward-looking statements. This report contains forward-looking statementsregarding, among other topics, our expected financial position, results ofoperations, cash flows, strategy, budgets and management’s plans andobjectives. Accordingly, these forward-looking statements are based onassumptions about a number of important factors. While we believe that ourassumptions about such factors are reasonable, such factors involve risks anduncertainties that could cause actual results to be different from what appearhere. These risk factors include: without limitation: declining sales by ourElectronika subsidiary, our relatively limited customer base, risks infulfilling military subcontracts, our ability to finance operations, continuedgovernment production of the Hellfire II missile system for which we supplyparts, the ability to adequately pass through to customers unanticipated futureincreases in raw material costs, decreased demand for products, delays indeveloping new products, markets for new products and the cost of developingnew markets, expected orders that do not occur, loss of key customers, theimpact of competition and price erosion as well as supply and manufacturing constraints,and other risks and uncertainties. In light of these risks and uncertainties,there can be no assurance that the forward-looking information contained inthis report will prove accurate. Accordingly, our actual results may differmaterially from these forward-looking statements. We assume no obligation toupdate any forward-looking statements made herein.*

 

**Item2.       Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

 

*Overview*

 

Torotel, Inc. (“Torotel”) conducts businessprimarily through three wholly owned subsidiaries, Torotel Products, Inc.(“Torotel Products”), Torotel Manufacturing Corp. (“TMC”),  andElectronika, Inc. (“Electronika”).  TMC provides manufacturingservices to Torotel Products.

 

Torotel Productsdesigns and manufactures a wide variety of magnetic components for use inmilitary, aerospace and industrial electronic applications.  Thesemagnetic components, which consist of transformers, inductors, reactors,chokes, and toroidal coils, are used to modify and control electrical voltagesand currents in electronic devices.  For example, if equipment containingone of these components receives an electrical voltage or current which is toohigh for proper operation of the equipment, the component would modify andcontrol the electrical voltage or current to allow proper operation of theequipment.  While Torotel Products primarily manufactures the componentsin accordance with pre-developed mechanical and electrical requirements, insome cases it will be responsible for both the overall design and manufactureof the components.  The magnetic components are sold to manufacturers whoincorporate them into an end-product.  The major applications includeaircraft navigational equipment, voice and data secure communications, medicalequipment, avionics equipment, down-hole drilling and conventional missileguidance systems.

 

Torotel Productsmarkets its components primarily through an internal sales force and throughindependent manufacturers’ representatives paid on a commission basis. These commissions are earned when a product is sold and/or shipped to acustomer within the representative’s assigned territory.  Torotel Productsalso utilizes its engineering department in its direct sales efforts for thepurpose of expanding its reach into new markets and/or customers.

 

Torotel Products isan approved source for magnetic components used in numerous military andaerospace systems, which means Torotel Products is automatically solicited forany procurement needs for such applications.  The magnetic componentsmanufactured by Torotel Products are sold primarily in the United States, andmost sales are awarded on a competitive bid basis.  The markets in whichTorotel Products competes are highly competitive.  A substantial number ofcompanies sell components of the type manufactured and sold by TorotelProducts.  In addition, Torotel Products sells to a number of customerswho have the capability of manufacturing their own electronic components. The principal methods of competition for electronic products in the marketsserved by Torotel Products include, among other factors, price, on-timedelivery performance, lead times, customized product 

 

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engineering and technical support, marketingcapabilities, quality assurance, manufacturing efficiency, and existingrelationships with customers’ engineers.  While magnetic components arenot susceptible to rapid technological change, Torotel Products’ sales, whichdo not represent a significant share of the industry’s market, are susceptibleto decline given the competitive nature of the market.

 

Electronika is amarketing and licensing company selling ballast transformers to the airlineindustry.  These transformers activate and control the lights incommercial airplane cockpits.  Electronika’s ballast transformers areapproved as spare and replacement parts in DC-8, DC-9, DC-10, MD-80 and MD-88aircraft; however, sales of ballast transformers have been made primarily foruse in DC-8 and DC-9 aircraft.  As a result, the business of Electronikais subject to various risks including, without limitation, any decline in use ofthe referenced aircraft, and competition for the available spare partsbusiness.  Electronika’s sales do not represent a significant portion ofany particular market.

 

Electronika’srequirements for ballast transformers are outsourced pursuant to a ManufacturingAgreement with Magnetika, Inc. (“Magnetika”), a corporation owned by theCaloyeras family, which presently owns approximately 43% of the common sharesof Torotel. Under the terms of the agreement, Magnetika provides all necessaryraw material, labor, testing, packaging and related services required tocomplete the manufacture, delivery and sale of the ballast transformers, andElectronika is obligated to order all of its ballast transformer requirementsexclusively from Magnetika. Electronika retains ownership of all designs,drawings, specifications and intellectual property rights associated with theballast transformers. In exchange for the services provided to Electronikaunder the Manufacturing Agreement, Magnetika receives 40 percent of the netsales price of all ballast transformers sold by Electronika. The ManufacturingAgreement continues in effect until April 1, 2012. In the three monthsended July 31, 2010, Electronika incurred costs of $4,000 for goodspurchased on trade terms of net 20 days pursuant to the ManufacturingAgreement. Of the amount purchased, $4,000 was due and payable as of July 31,2010.

 

*Business Outlook*

 

Notwithstanding the current economic climate anduncertainty surrounding the next U.S. defense budget, we believe our overall businessoutlook remains favorable due to higher demand for the potted coil assembly forthe Hellfire II missile system and a higher shippable backlog for magneticcomponents. Additionally, we believe a new long-term contract in excess of$5.0 million for the potted coil assembly will be awarded later incalendar 2010, although there can be no assurance the contract will be awardedor when sales under the contract would commence. As of July 31, 2010, theconsolidated order backlog was nearly $5.9 million. This amount iscomprised of $3.0 million for the potted coil assembly, $2.5 millionin magnetic components and $400,000 in electro-mechanical assemblies. New orderbookings during the first three months of fiscal 2011 decreased 86% to $750,000.  New order bookings exclusive of the pottedcoil assembly contract received in the first quarter last year decreased  nearly 1% to $750,000.

 

The industry mix of Torotel Products’ net sales forthe first three months in fiscal 2010 was 62% defense, 20% aerospace and 18%industrial compared to 43% defense, 36% aerospace and 21% industrial for thesame period last year. We believe the mix in fiscal 2011 will remain weightedprimarily towards defense, but with an increase in the industrial category dueto a significant contract signed in February, 2010.

 

The primary factors that drive gross profit and netearnings for Torotel Products are sales volume and product mix. The grossprofits on mature products/programs and complex transformer devices tend to behigher than those that are still in the prototyping or early production stagesand simpler inductor devices. As a result, in any given accounting period themix of product shipments between higher and lower margin jobs has a significantimpact on the gross profit and net earnings of Torotel Products. Torotel’soperating plan continues to focus on expanding the product base beyondelectronic components.

 

Electronika’s net sales continue to be impacted by thedecline in the number of active DC-8 and DC-9 aircraft. We expect these salesto continue to decline and eventually phase out with the expiration of themanufacturing agreement.

 

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* *

*Results of Operations*

 

The followingmanagement comments regarding Torotel’s results of operations and outlookshould be read in conjunction with the Consolidated Condensed FinancialStatements included in Item 1 of this Quarterly Report.

 

This discussion andanalysis of the results of operations include the operations ofTorotel, Inc. and its subsidiaries, Torotel Products, Inc., TorotelManufacturing Corp., and Electronika, Inc.  While each company’sresults are included in the following discussion, segment reporting is notapplicable because the products offered are similar in form and function, andtarget similar markets.

 

**Three Months Ended July 31, 2010Compared With Three Months Ended July 31, 2009**

 

For the reasons discussed below, the consolidated pretaxearnings increased from a loss of $109,000 to a profit of $215,000.  Thepretax loss of Torotel decreased from $148,000 to $141,000.  The pretaxearnings of Torotel Products increased from $38,000 to $351,000.  Thepretax earnings of Electronika increased from $1,000 to $5,000.

 

Consolidated net sales increased 62%.  The netsales of Torotel Products increased 62% from $1,536,000 to $2,485,000. This increase was attributable to higher demand for the potted coil assemblyand higher demand for magnetic components and assemblies.  The net salesof Electronika increased from $1,000 to $9,000, which is consistent with thesales volume we expect from Electronika until the expiration of theManufacturing Agreement.

 

Consolidated gross profit as a percentage of net salesremained unchanged.  The gross profit percentage of Torotel Productsremained unchanged.  Electronika’s gross profit as a percentage of netsales also remained unchanged.

 

Engineering expenses, applicable only to TorotelProducts, decreased 25% from $92,000 to $69,000 because of a $28,000 decreasein payroll costs due to fewer engineering personnel offset by a $5,000 increasein training costs.  We do not anticipate a significant increase in thelevel of engineering expenses during the next few quarters.

 

Consolidated selling, general and administrative(SG&A) expenses increased nearly 9%.  The SG&A expenses of Toroteldecreased 5% from $148,000 to $141,000 primarily because of a $29,000 decreasein accounting fees partially offset by a $24,000 increase in professionalfees.  The SG&A expenses of Torotel Products increased 11% from$410,000 to $465,000 primarily because of a $23,000 increase in training costs,a $13,000 increase in recruiting costs an $11,000 increase in bad debt allowance,and a $9,000 increase in consulting costs.  Electronika did not incur anySG&A expenses in either period.  We do not anticipate a significantincrease in the level of SG&A expenses during the next few quarters.

 

Interest expense, entirely attributable to TorotelProducts, decreased 17% because of a lower debt level (see Note 5 of Notes toConsolidated Condensed Financial Statements).

 

Interest income, entirely attributable to TorotelProducts, increased $3,000 due to interest earned on certain cash balances.

 

**Liquidity and Capital Resources**

 

As ofJuly 31, 2010, Torotel had $704,000 in cash compared to $1,030,000 as ofApril 30, 2010 and $520,000 as of July 31, 2009.  Managementanticipates cash flow from operations to improve from current levels during thenext few quarters given the current shippable backlog position.

 

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The tablebelow presents the summary of cash flow for the three month periods indicatedthrough July 31.

 
| ** **                                          | ** ** | **2010** | ** ** | **2009** | ** ** |
|-----------------------------------------------------|------------|----------|------------|----------|------------|
| Net cash used in operating activities               |       | $        | (254,000   | )        | $          | (107,000 | ) |
| Net cash used in investing activities               |       | $        | (47,000    | )        | $          | (30,000 | ) |
| Net cash provided by (used in) financing activities |       | $        | (25,000    | )        | $          | 1,000 |   |

 

Net cashprovided by operating activities fluctuates between periods primarily as aresult of differences in operating earnings, the timing of shipments and thecollection of accounts receivable, changes in inventory, level of sales andpayment of accounts payable.  The $47,000 of cash used in investingactivities in the first three months of fiscal 2011 was the result of capitalexpenditures.  Management anticipates a higher level of capitalexpenditures during the remainder of fiscal 2011.  The $25,000 of cashused in financing activities in the first three months of fiscal 2011 is thenet effect of long-term debt payments and capital lease obligations.  Webelieve that the projected cash flow from operations, combined with existingcash balances, will be sufficient to meet funding requirements for theforeseeable future.  Torotel does have a $500,000 bank line of creditavailable through September 30, 2010, which we anticipate could beutilized to help fund any working capital requirements.  We expect to renew the credit line withsimilar terms.

 

We believethat inflation will have only a minimal effect on future operations since sucheffects should be offset by sales price increases, which are not expected tohave a significant effect upon demand.

 

Return on Capital Employed (“ROCE”) is the primarybenchmark used by management to evaluate Torotel’s performance. ROCE measureshow effectively and efficiently net operating assets (NOA) are used to generateincome before interest and taxes (EBIT). For these purposes, NOA, or CapitalEmployed, is defined as “accountsreceivable + inventory + net fixedassets + miscellaneous operating assets - accounts payable -miscellaneous operating liabilities”. The performance of Torotel’s managementand the majority of its decisions will be measured by whether Torotel’s ROCEimproves. For the fiscal years ended April 30, 2008, 2009 and 2010,Torotel’s ROCE was 12.25%, 18.19% and 1.13%, respectively.  The ROCE forthe 12-month trailing period ended July 31, 2010 was 15.95%.  Thisincrease in ROCE is partially attributed to the year to date operatingprofit.  We believe that ROCE should improve over the next few quarters.

 

**Critical Accounting Policies**

 

*Use of Estimates*

 

The preparation of the consolidated financialstatements in conformity with accounting principles generally accepted in theUnited States of America requires management to make estimates and assumptionsthat affect certain reported amounts and disclosures.  Significantestimates used in preparing these consolidated financial statements includethose assumed in computing the carrying value of equipment, allowance fordoubtful accounts receivable, the valuation allowance on deferred tax assetsand the reserve for warranty costs.  Accordingly, actual results coulddiffer from those estimates.  Any changes in estimates are recorded in theperiod in which they become known.

 

*Credit Risk*

 

Financial instruments that potentially subject Torotelto concentrations of credit risk consist principally of cash and accountsreceivable.  Torotel grants unsecured credit to most of itscustomers.  Management does not believe that it is exposed to anyextraordinary credit risk as a result of this policy.  At various times,and at July 31, 2010, cash balances exceeded federally insuredlimits.  Torotel has not experienced any losses in the cash accounts and managementdoes not believe Torotel is exposed to any significant credit risk with respectto its cash.

 

*Fair Value of Financial Instruments*

 

Torotel determines fair value by utilizing a fairvalue hierarchy that prioritizes observable and unobservable inputs used tomeasure fair value into three levels as follows:

 

·                  Level1.  Inputs to the valuation methodology are quoted prices (unadjusted) foridentical assets or liabilities in active markets.

 

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·                  Level2. Inputs to the valuation methodology include quoted prices for similar assetsand liabilities in active markets, and inputs that are observable for the assetor liability, either directly or indirectly, for substantially the full term ofthe financial instrument.

 

·                  Level3.  Inputs to the valuation methodology are unobservable and significantto the fair value measurement.

 

The fair value hierarchy gives the highest priority toLevel 1 inputs and the lowest priority to Level 3 inputs.  In determiningfair value, Torotel utilizes valuation techniques that maximize the use ofobservable inputs and minimize the use of unobservable inputs to the extentpossible as well as consider counterparty credit risk in the assessment of fairvalue.

 

The carrying amounts of certain financial instruments,including cash, trade receivables, prepaid expenses and other current assets,trade accounts payable and accrued liabilities approximate fair value due totheir short maturities.  As of July 31, 2010, the amount of Torotel’slong-term debt approximates fair value based on the present value of estimatedfuture cash flows using a discount rate commensurate with a borrowing rateavailable to Torotel.

 

*Treasury Stock*

 

Torotel utilizes the weighted average cost method inaccounting for its treasury stock transactions.

 

*Revenue Recognition*

 

Revenue is recognized when a fixed price contract orpurchase order exists; delivery has occurred; and collection is reasonablyassured.  Selling terms are FOB Shipping Point so Torotel considers itsproducts delivered once they have been shipped and title and risk of loss havebeen transferred.  Torotel’s consolidated net sales arising from contractshaving deliveries scheduled over a period of more than one year for the threemonth periods ended July 31, 2010 and 2009, were approximately 43% and32%, respectively, primarily related to the long term contracts for the pottedcoil assembly.

 

*Allowance for Doubtful Accounts*

 

Gross trade accounts receivable are offset with anallowance for doubtful accounts.  The allowance for doubtful accounts ismanagement’s best estimate of the amount of probable credit losses in Torotel’sexisting accounts receivable.  Management reviews the allowance fordoubtful accounts on a regular basis, and all past due balances are reviewedindividually for collectability.  Account balances are charged against theallowance when placed for collection.  Recoveries of receivables previouslywritten off are recorded when received.  The majority of the customeraccounts are considered past due after the invoice becomes older than thecustomer’s credit terms.  Interest is not charged on past dueaccounts.  The allowance for doubtful accounts as of July 31, 2010and April 30, 2010, was $17,000 and $6,000, respectively.

 

*Inventories*

 

Inventories are stated at the lower of cost or market.Cost is determined using a moving average cost method of valuation thatcurrently and historically approximates the first-in, first-out method. Exceptas described above in “Revenue Recognition,” Torotel’s industry ischaracterized by short-term customer commitments and changes in demand, as wellas other market considerations. Provisions for obsolete and excess inventoryare based on reviews of inventory usage, quantities on hand and latest productdemand information from customers. Inventories are reviewed in detail utilizinga 12-month time horizon. Individual part numbers that have not had any usage orpurchases in a 12-month time period and do not have any known usagerequirements are categorized as obsolete; individual part numbers having morethan a 12-month supply based on the current year’s usage are categorized asexcess. Once specific inventory has been identified as excess or obsolete, thecost of the identified inventory is fully reserved and the cost of theinventory is not recovered until it is sold. The reserve balance is analyzedfor adequacy as part of the inventory review each quarter.

 

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* *

*Property, Plant and Equipment*

 

Property, plant and equipment are carried atcost.  Depreciation and amortization are provided in amounts sufficient torelate the costs of depreciable assets to operations primarily using thestraight-line method over estimated useful lives of three to five years forequipment and ten to twenty years for buildings and improvements.

 

*Cash Flows*

 

For purposes of the statements of cash flows, Torotelconsiders all short-term investments purchased with original maturity dates ofthree months or less to be cash equivalents.

 

*Warranty Costs*

 

Torotel maintains a reserve for estimated warrantycosts associated with products returned from customers.  A limitedwarranty is provided for a period of one year which requires Torotel to repairor replace defective products at no cost to the customer.  The warrantyreserve is based on historical experience and reflects management’s bestestimate of probable liability under the product warranties.

 

*Stock-based Compensation*

 

Torotel follows the fair value recognition provisionsin accounting for transactions involving stock appreciation rights andrestricted stock.

 

*New Accounting Pronouncements*

 

Torotel adopted ASU No. 2009-17 Consolidations(Topic 810), *Improvements to Financial Reporting byEnterprises Involved with Variable Interest Entities*.  This update requires a qualitative approachto identifying a controlling financial interest in a variable interest entity (“VIE”)and requires ongoing assessment of whether an entity is a VIE and whether aninterest in a VIE makes the holder the primary beneficiary of the VIE.  In addition, this new guidance requiresadditional disclosures about the involvement with a VIE and any significantchanges in risk exposure due to that involvement.  This new guidance is effective for fiscalyears beginning after November 15, 2009. At adoption and as of July 31, 2010, we were not involved in anyVIE and there was no impact from adoption.

 

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** **

**Item 3.            Quantitativeand Qualitative Disclosures About Market Risk**

 

Not Applicable

 

**Item 4T.   Controls and Procedures**

 

*Evaluation of Disclosure Controlsand Procedures*

 

Torotel’s management, with the participation of theChief Executive Officer and Chief Financial Officer, has evaluated theeffectiveness of Torotel’s disclosure controls and procedures, as such term isdefined in Rules 13a-15(e) and 15d-15(e) under the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”), as of the end of theperiod covered by this report.  Based on such evaluation, these officershave concluded that Torotel’s disclosure controls and procedures are effective.

 

*Changes in Internal Controls*

 

There were no significant changes in Torotel’sinternal controls over financial reporting or in other factors that inmanagement’s estimates have materially affected, or are reasonably likely tomaterially affect, Torotel’s internal controls over financial reportingsubsequent to the date of the evaluation.

 

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**PART II.   OTHER INFORMATION**

 

**Item 6.   Exhibits**

 

a)                                                        Exhibits

 
| Exhibit 31.1 |   | Officer  Certification                                                                                                             |
|-------------------|--------|------------------------------------------------------------------------------------------------------------------------------------|
| Exhibit 31.2 |   | Officer  Certification                                                                                                             |
| Exhibit 32.1 |   | Certification Pursuant to 18 U.S.C. Section 1350,  as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002  |
| Exhibit 32.2 |   | Certification Pursuant to 18 U.S.C.  Section 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |

 

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**SIGNATURES**

 

Pursuant tothe requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.

 

 
| ** **               | ** ** | **Torotel, Inc.**          |
|--------------------------|------------|---------------------------------|
| ** **               | ** ** | **(Registrant)**                |
|                     |       |                            |
|                     |       |                            |
| September 14,  2010 |       | /s/ Dale  H. Sizemore, Jr. |
| Date                     |       | Dale H.  Sizemore, Jr.     |
|                     |       | Chief  Executive Officer        |
|                     |       |                            |
| September 14,  2010 |       | /s/ H.  James Serrone           |
| Date                     |       | H. James  Serrone.              |
|                     |       | Chief  Financial Officer        |

 

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